COMMERCIAL REAL ESTATE; Warehouse Vacancy Rates Are Up as Rents Fall

Out on the western edge of St. Cloud, Minn., there is a 1.1 million-square-foot box, put there in part because the city is not much farther from any one big coastal American city than from any other. It was built for the single purpose of gathering baseball bats and sofas and coffee makers and all manner of goods together in one place, where they could be packaged into made-to-order bundles and sent out to the homes of customers.

The structure's interior is completely automated, with racking systems, conveyer belts, scales and bar-code scanners -- $7.5 million worth of improvements in all to a plot of land worth less than $600,000. The use of technology was appropriate for the owner, the Fingerhut Corporation, an e-commerce unit of Federated Department Stores Inc. that is headed for liquidation after talks to sell the business fell through last week. The company also has warehouses in Spanish Fork, Utah, and Piney Flats, Tenn.

They are prized assets, but they could be difficult to sell.

The warehouse industry is in a slump all over the country, with vacancy rates rising to 9.9 percent nationwide at the end of the first quarter from 7.5 percent in the quarter a year ago, according to Cushman & Wakefield, the real estate brokerage and services company. In the corresponding period, annual asking rental rates have fallen to $5.75 a square foot from $6.16.

Some of the most stagnant property listings in the portfolios of real estate brokers -- although probably accounting for less than 1 percent of all warehouse space, brokers and analysts said -- are the facilities used by all the vanquished rivals of Amazon.com.

''Kind of a double whammy when the bottom fell out was that these e-commerce companies had built and leased not only big buildings, but big buildings with specialized equipment,'' said James L. Dieter, executive managing director of the United States industrial group at Insignia/ESG, a commercial real estate services company.

While e-commerce companies owned and leased a negligible amount of warehouse property in the overall market, they helped alter the way companies approach storage and delivery. They shuffled priorities for industrial space in an evolution that was helped along by advances in logistics technology and a shift toward reliance on delivery by third parties.

In the current market, landlords are making plans based on their contrasting views of the way companies will reset their priorities for warehouse space in the future, at the same time those companies are re-evaluating storage and transportation strategies and making few leasing or purchase deals. Though the pace of construction has quickly diminished, speculative building has glutted the market nationwide, and vacancy rates are rising and rents falling as companies cut costs in a soft economy, and as they tinker with delivery patterns.

In the nationwide industrial real estate market, 17.1 million square feet of space have been completed so far this year, according to Cushman & Wakefield. Of that amount, warehouse space accounted for 14.4 million square feet, and the other categories -- high-tech, manufacturing, office service and other -- accounted for more than 2.7 million square feet. Cushman estimates that the total amount of existing industrial space is 7 billion square feet, including 4 billion square feet of warehouse space.

''We got a tremendous amount of vacancy from overbuilding,'' said Thomas T. Lynn, executive vice president in the Dallas office of the Staubach Company, a real estate services concern. He attributed the continued pace of construction, even as the state of the economy declined, to ''the herd mentality of developers. It was working, just like in the 80's, buildings were being built, and they were being leased.''

Owners that are seeking to fill empty space are resorting to incentives that include waiving payment for part of the lease term.

''We are starting to see free rent, which we haven't seen in many years,'' said David R. Kahnweiler, president of Colliers Bennet & Kahnweiler, a corporate real estate company in Chicago.

Investment firms suggest that the sluggishness presents an opportunity. A new draft report by Laler DeCosta II and Steve Walker of Lend Lease Real Estate Investments makes the case that ''investing in mature locations in the biggest industrial markets is a strategy for success, even if the most contemporary product is unavailable.''

Whether investors accept that depends on their view of how companies will adjust their inventory patterns. And there are development companies and property owners to represent nearly every view.

''There is going to be net less demand for warehouse space, particularly warehouse space for storage,'' said Hamid R. Moghadam, chief executive of the AMB Property Corporation, an industrial real estate investment trust based in San Francisco that owns more than 900 buildings.

Mr. Moghadam's company lost more than $20 million investing in Webvan, an online grocer that closed last summer. Their warehouses were retrofitted with 100-foot-long computerized lazy susans and other high-technology modifications. On pure property though, Mr. Moghadam said his company his come through the experience well because the three facilities ABM still owns that it once leased to Webvan are small and close to city centers, characteristics he thinks companies will find desirable as they shift storage and delivery patterns. He has told investors that two of the facilities have new tenants.

Trammell Crow has a different view, one that includes a vision of an eventual need for millions of square feet of new warehouse space. Burned in the last slump by its holdings in land, the company has concentrated on structuring joint development agreements to keep all but about 20 of the 1,000 acres on which it intends to build warehouses sheltered from the balance sheet. The company is waiting until the properties can be leased before building.

In contrast, ProLogis owns 1,600 acres around the country, enough to develop 32 million square feet of warehouse space. The company's strategy is based on the same belief held by Mr. Moghadam, that companies will keep shrinking rather than increasing the amount of space they use, but that they will simultaneously shift to different, smaller facilities. That prospect would seem to leave developers with the same problem of too much space.

''Not if you're gaining market share,'' said John W. Seiple, the company's president. He said ProLogis is holding so much land, a gambit that seems to simultaneously contradict his stated agreement with AMB and ignore the worries about land ownership and interest payments expressed by Trammell Crow, because the land is a resource needed to fill new demands.

Building only for committed tenants did little to protect the industrial developers from the most recent downtown in the economy.

''When landlords underwrote facilities as single tenant facilities in an obscure location, they were really underwriting the tenant's credit as opposed to the asset itself,'' said Gregory Whyte, a managing director of Morgan Stanley Dean Witter who is responsible for covering commercial real estate investment trusts.

Some developers said they would refuse to build for tenants in particular industries, like e-commerce. This has not proven to be a perfect fix. In Mira Loma, a suburb of Los Angeles, there is a 750,000-square foot building outfitted like the Fingerhut warehouse in St. Cloud. ToysRUs.com put in expensive conveyer systems but never moved in, and the landlord had to find a new tenant. That new tenant, which moved in less than 18 months ago, is Kmart, a traditional retailer that has since filed for protection from creditors under Chapter 11 and is reorganizing.